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TRANSCRIPT
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International CorporateGovernance
Reading: Chapter 1 (pages 3-21)
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Lecture Outline
What is Corporate Governance?
Internal Mechanisms
External Mechanisms
Convergence Measuring Corporate Governance
Benefits of Good Governance
What you need to remember
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Introduction
Company founded (owned and managed) by individual,
family, partnership, government or company.
Stage 1:
Stage 2:
Company expands by issuing more equity and debt.
New equity holders also get voting rights as to who
manages the company.
Equity New Equity Debt
Equity
Voting Rights
Voting Rights Voting Rights
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Introduction
Company founder must now choose between keepingcontrol of the company or allowing the company to be
managed by professional managers.
If they keep control there is a potential conflict between
the founders and other shareholders.
If they pass management to professional managers there
is a potential conflict between owners and managers.
Equity New Equity Debt
Voting Rights Voting Rights
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What is Corporate Governance?
Corporate governance is about minimizing the loss ofvalue that results from the separation of ownership
and control.
It deals with the ways in which suppliers of finance
to corporations assure themselves of getting a return
on their investment.
While corporate governance has been a hot issue in
recent years (Enron, Worldcomm, HIH and One.Tel)it is a problem that has been around for hundreds of
yearsAdam Smith (1776).
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Good corporate governance practices involve: The corporate governance framework should protect
shareholders rights.
The corporate governance framework should ensure the
equitable treatment of all shareholders.
Stakeholders should be involved in corporate
governance.
Disclosure and transparency is critical.
The board of directors should be monitored and held
accountable for what guidance it gives.
What is Corporate Governance?
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Internal Mechanisms
Board of Directors Board Size & Independence
Chairman/CEO Positions
Board Committees
Executive Compensation
Ownership Structure
Concentrated versus Dispersed Ownership
Identity of Owners
Other Blockholders
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External Mechanisms
External Auditors
Debt & Equity Markets
Monitoring by debt holders
Analysts
Mergers & Acquisitions
Legal/Regulatory System
Common versus Civil Law
Extent of Law Enforcement
Recent RegulationsSarbanes Oxley Act, ASX Good
Corporate Governance Principles
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International Differences
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Board of Directors
The board of directors is responsible for overseeingmanagement and representing shareholders interests.
US and Australia have single-tiered boards, headed
by a Chairman of the Board. The CEO and other
executives usually also sit on the board.
Some other countries (Germany, Indonesia) have
two-tiered boards. The roles and composition of the
two boards can differ.
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Board Size
Boards should be an appropriate sizenot too bignot too small.
Depending on the size of the company within the
range of 5-15 is normal.
If the board is too small, there is a lack of
monitoring.
If the board is too big, there are problems reaching a
consensus for decision making.
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Board Independence
Boards should have a majority/high proportion ofoutside/independent directors.
Outside/independent directors should have no
personal interest in the company and therefore are
more effective monitors.
But, it is also a good idea to have some company
insiders (CEO, executives) on the board to provide
the board with a better understanding of thecompanys operations.
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Chairman/CEO Positions
The Chairman of the Board is responsible foroverseeing the board of directors.
The CEO is responsible for the day-to-day running of
the company.
In family-controlled companies it is common for the
same person or relatives to hold both of these
positions. But, this concentrates power and reduces
monitoring. Therefore, the positions of Chairman and CEO
should be separated.
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Board Committees
The board of directors can delegate certain duties toboard committeesthis can provide increased
monitoring on specific issues.
Audit committeeresponsible for internal audit
function and appointment of external auditor.
Remuneration committeeresponsible for setting
appropriate compensation for directors and
executives. Nomination committeeresponsible for finding
appropriate directors and executives.
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Executive Compensation
Compensation of top executives can be used to tie theinterests of the executives to those of shareholders.
Variable performance packages are preferred:
If they perform well, they are rewarded.
If they perform poorly, they are not rewarded or fired.
Alignment of interests is usually achieved through:
Stock ownership
Stock options
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Ownership Structure
Australian and US companies are usually owned bywidely-dispersed shareholders and controlled by
professional managers. This means that no single
party is in control of the company.
However, in other nations around the world,
ownership is usually concentrated in the hands of
family groups or government entities. This means
that one group is in control of the company and thereis very little you can do (other than sell) if you dont
like what theyre doing.
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Ownership Structure
Company Largest
Shareholder
Shareholder
Identity
Top 20 Shareholders
BHP 17.22% Nominee 74.48%
Commonwealth Bank 8.70% Nominee 61.90%
Westfield 5.01% Company 23.53%
Singapore Air 56.76% Government 93.83%
Formosa Plastics 34.12% Family 45.04%
Hutchison Whampoa 51.79% Family 92.11%
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Ownership Structure
The identity of the controlling owner can also havecorporate governance implications.
Family-controlled companies use cross-holdings and
pyramidal structures to gain effective control of the
company with the least cash ownership. The market
recognizes this and prices the increased risk of
expropriation into the share price.
Government-owned and widely-held companies aremore likely to follow the rules.
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Ownership Structure
The presence of an non-management relatedblockholder of shares can increase monitoring of the
firm.
A blockholder usually holds at least 5% of the
outstanding shares, therefore has a significant interest
in the future performance of the company.
Blockholders can be governments, financial
institutions, individuals or other companies.
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External Auditors
Stock exchange listing requirements usually make itmandatory for companies to employ an external
auditor to audit their financial statements (and
internal controls).
External auditor should be independent of
management, but .
Tenure of auditor
Tenure of audit partner
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Monitoring by Debt holders
Debt holders provide capital to the company usuallywith conditions:
Debt covenants
Secured on assets
Therefore debt holders actively monitor management
to ensure that companies are meeting debt conditions
and that they wont default.
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Analysts
Securities analysts are professionals employed byinvestment banks / brokers / asset managers to
monitor companies and provide stock
recommendations (buy/sell), earnings forecasts, long-
term growth forecasts, target prices etc.
Provides an extra level of monitoring for investors.
But, analysts incentives/conflicts of interest meanthat not all of their output is trustworthy.
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Takeover Market
The merger and acquisition (M&A) market stands asa court of last resort for assets that are not being
utilized to their full potential.
If management are underperforming there is a good
chance that this will be noticed by the market and
other players will want to take control of the
company.
There are active takeover markets in Australia, US,UK, New Zealand, but few other countries.
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Intervening Variables
Measures put in place by companies that restrictshareholder rights and the effectiveness of takeover
markets:
Staggered boards
Limits to by-law/charter changes
Supermajority requirements for mergers
Poison pills
Golden parachutes
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Legal Systems
Each countrys legal system has built in a certaindegree of investor protection. However, there is a
wide variation in protection and enforcement of these
rules around the world.
Common law countries provide highest protection
and French civil law countries provide the least
protection.
Low investor protection seems to result inconcentrated ownership and underdeveloped equity
markets.
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Legal Systems
Country Legal System Protection Rule of Law
Australia Common law 4 10
France French Civil law 2 8.98
Germany German Civil law 1 9.23
India Common law 5 4.17Japan German Civil law 4 8.98
Korea German Civil law 2 5.35
Philippines French Civil law 3 2.73
Netherlands French Civil law 2 10
UK Common law 5 8.57
USA Common law 5 10
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Recent Regulations
In response to the Enron crisis in the US, theSarbanes Oxley Act was passed in 2002. This has
significantly increased governance practices and the
personal liability of directors in the US.
Most other nations have issued Corporate
Governance Best Practice Guidelines to assist
companies in improving their governanceASX
Corporate Governance Guidelines & Best PracticeGuide (on OLT site). But these are voluntary!
BHP website BHP Annual report
http://www.bhpbilliton.com/bb/home.jsphttp://www.bhpbilliton.com/bb/investorsMedia/reports/2006/2006BhpBillitonAnnualReportPage.jsphttp://www.bhpbilliton.com/bb/investorsMedia/reports/2006/2006BhpBillitonAnnualReportPage.jsphttp://www.bhpbilliton.com/bb/home.jsp -
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Convergence?
Originally there were market-based, family-based,bank-based, government-affiliated systems.
In recent years, most nations have started to promote
US and UK best practice corporate governance
guidelines. But not all companies are adopting these
measures.
There is evidence that family-controlled companies
in particular are refusing to improve their corporategovernance practices.
Asian Corporate Governance Association
http://www.acga-asia.org/http://www.acga-asia.org/ -
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Measuring Corporate Governance
Understanding what good corporate governance isabout is quite easy. However, it is difficult tomeasure whether companies are really committed togood governance.
All we can do is measure if they have certaincorporate governance mechanisms in placewedont know if they are effective or not!
Organizations such as Standard and Poors and Credit
Lyonnais Securities Asia have started providingcorporate governance ratings in recent years.
S&P
http://www2.standardandpoors.com/portal/site/sp/en/ap/page.article/2,1,1,0,1021558139012.html?vregion=ap&vlang=enhttp://www2.standardandpoors.com/portal/site/sp/en/ap/page.article/2,1,1,0,1021558139012.html?vregion=ap&vlang=en -
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Benefits of Good Governance
Researchers have shown that companies with goodcorporate governance practices are valued more
highly and run more effectively.
So the benefits of good governance include:
Higher share price
Lower cost of funds
Greater international following
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What you need to remember
When investing it is worthwhile keeping in mindwhether a company has committed to good corporate
governance or not. You can use the mechanisms
highlighted in this lecture or corporate governance
ratings as a guide.
Corporate governance becomes most important
during stock market crashes and bad economic times.
But, it is not a perfect science. Managers will alwaysfind a way to circumvent monitoring to achieve their
own goals!